Where does the 50% rule come from? 90 posts by 21 users

Posted: 03/22/2008 at 07:34PM

I know the " 50% rule" is bandied about as gospel here in the forums, but haven't seen any actual, hard data that says that operating expenses tend to be ~50% of gross rent income. I'd like to verify this number is, in fact, accurate. (I believe that it probably is; but I owe it to myself to verify my assumptions, right?)

It would not only help me ensure that I'm using realistic numbers, I also think that it would be good data (ammunition?) to have when negotiating.

Can anyone provide links to studies that address operating expenses as a percentage of gross rent income? The little searching I've done hasn't yielded anything.

Posted: 03/22/2008 at 09:48PM

I have seen this ratio numerous times in other places. Its a very common rule of thumb for multi-families. I've seen it in several books, including Dave Lindahl, who was recently mentioned here.

The reality is that may guru type books never mention any number for expenses. The leave it up to you to try to figure this out.

In other places when discussing single families, I've seen slightly lower ratio's used, 40% or so.

Its been discussed numerous times. Do a search and you'll find some of those other discussions. In one, someone listed all their recent expenses. That list didn't include vacancies, just actual expense vs. actual collected rent. Adding vacancy and comparing to scheduled rent, it was very close to 50%.

A bunch of the items are regular and period, and its pretty easy to come up with actual numbers. The tough ones are the irregular ones that only happen once in a great while. Those are unexpected and unplanned, and can be quite expenses. New roofs or furnaces, major tenant damage, or a lengthy eviction. You may get lucky and not have any of those for a long time. Or, you may get socked with one right out of the chute.

on

Posted: 03/24/2008 at 06:06AM

NogginBoink,

When I first started in the rental business, I read all the " guru" nonsense books. By the time I was in business a year, I had probably read 30-40 books and had seen many " gurus" talk. Most of the " gurus" never mention expenses because they are trying to upsell the " student" to a more expensive course, bootcamp, or training. Of the gurus that did mention expenses, several talked about taxes and insurance. Others talked about taxes, insurance, management and maintenance. At the one year point, I had about 10 rentals and had been very lucky. I hadn't had a single vacancy or any other irregular expense, such as evictions, court costs, damage done by tenants (in excess of the deposit), etc. I felt like a GENIUS! I thought that I had found a business that simply made money hand over fist!!!

Unfortunately, that was short lived. As my portfolio continued to grow, I had a vacancy. Then an eviction. Then damage done by a tenant. Then a drug bust. Etc, etc, etc. In other words, I began to experience the REALITY of the business, which was quite a bit different than the silly guru hype. I began to fell more like an IDIOT than a genius. Shouldn't I have known that tenants get evicted? Shouldn't I have known that there would be vacancies? Shouldn't I have known that tenants would damage my property? The answer was YES, I should have known, but instead I had chosen to be ignorant and believe the nonsense that I read in the dozens of guru nonsense books!!!

I knew that there had to be an answer out there. I started looking at all the apartment and rental housing data I could find. This data included hundreds of thousands of rental units throughout the United States. What I found out is that throughout the United States, operating expenses run 45% to 50% of the gross rents. That's where my " 50% Rule" came from.

The only thing that saved me from joining the majority of other newbies that fail is that I'm extremely competitive. After I bought one of my first houses, I heard of another investor that bought a house for the unbelievable price of $20,000. I knew that if that investor could do it, so could I. My competitive fangs came out and I was on the search for properties at a HUGE DISCOUNT. So, even though I didn't understand the operating expense issues at this early point, my competitiveness saved the day.

I've been preaching the " 50% Rule" every since, mainly because I was so frustrated that the gurus were either lying about the expenses or didn't understand them. That's how the " 50% Rule" came to be.

Mike

Posted: 03/24/2008 at 08:20AM

Thanks, everyone.

I believe the rule is accurate. But so far, all I have to base that on is personal anecdotes.

Are there any fomal studies that have been done that corroborate that? Something in print, with a respectable name behind it, that I can point to and say, " Listen, Mr. Seller, I don't care what you claim your expenses have been. The such-and-such organization did a study and found that the average NOE for this type of property is X. Here's a copy of their paper, and these are the numbers I'm using when I look at this deal."

While I do respect all of you and your experiences, seeing a study on this topic would help me a lot, both in negotiating and in understanding the business I'm wanting to enter.

Posted: 03/24/2008 at 03:28PM

NogginBoink,

I never argue with sellers about their expenses. In fact, if truth be told, I never even ask the seller about their expenses. Why? Because I wouldn't believe them even if they told me. The vast majority of landlords in the U.S. are individuals. The vast majority of newbie landlords fail in a relatively short period of time. That's why there is such a big turnover in the rental property business. One of the main reasons these newbies fail is that they don't understand the operating expenses or cash flow issues. I'm certainly not asking a failure for their expenses, profit, or anything of the kind. All I want to know is the purchase price and obviously to see the building and the leases. I will make up my own mind what the rents should be; what repairs are needed; what the expenses will be; and what the cash flow will be. I KNOW my market and the business. Chances are that the seller doesn't understand any of this - THAT'S WHY THEY'RE SELLING!

Good Luck,

Mike

Posted: 03/28/2008 at 01:15PM

Obviously, if you completely gutted and rehabbed the property, your capital expenses part of the equation is very high. The rehab is likely to make the maintenance a little lower, but in my experience, most of the maintenance is caused by the tenants, not by the age of the building. So, offsetting your high capital expenses, would be slightly lower maintenance expenses. Also, you must remember that the maintenance is only one of many parts of the operating expenses.

The point of the 50% rule is to say the operating expenses will work out to about 50% of the gross rents when averaged over time. It can not tell you what the operating expenses will be in any given year. That is IMPOSSIBLE to know.

Good Luck,

Mike

Posted: 03/28/2008 at 10:32PM

Great Motto: Shoot for the moon. Even if you miss, you'll land among the stars.
Les Brown

Posted: 03/29/2008 at 04:13AM

While I would love to wait on properties that meet the 50% rule, I tend to be more aggressive and get more deals done with a less strict policy.

Wheatie is exactly right. Being more aggressive and getting more deals done makes absolutely no sense IF you're in the rental business. Losing money is not a good strategy no matter how many rentals you buy! Moreover, the data from hundreds of thousands of rental units in the United States shows that operating expenses run 45% to 50% of the gross rents. Unless you are exempt or are working for free, then your operating expenses over many units and over time will be in the 45% to 50% range.

As Wheatie said, why not post your expense data, we'd love to see how you are exempt from the expenses that hundreds of thousands of your fellow landlords have experienced.

Some might say that I am more of a realist!

I would say that you are doing exactly what the average new landlord does. He pays too much for his rentals and then is out of business in a relatively short period of time. You are right, that is the REALITY of the situation - pay too much for rentals and you are certain to fail.

Mike

Posted: 03/29/2008 at 01:44PM

You're losing money. End of story. If you're buying " cashflowing" property in Indiana and are running negative $100 a month, you need to be in another business. I love this state but don't even try to say " appreciation" and " Indiana" in the same sentence unless it's forced appreciation at closing. It's a cashflow state. It's not Southern California.

Almost sorry (not really though) to be so blunt but guys like myself (and I'm going to stretch this and include Mike because I suspect he feels the same) are sick of 80% of the bullsh*% being sold in real estate investing circles and have found the 20% of information that truly makes us money. We drop 80% of the bullsh*% analysis for the 20% that we NEED to know. We drop 80% of the bullsh*% realtors for the 20% that take a minute to freakin' listen to us and deliver what we are looking for. When I'm buying, I'm analyzing in batches of 20 properties at a time have no time for " maybes" when all I want is basic, quick information that tells me whether or not a property is worth 30 seconds of my time to check out. The 50% rule saves me a lot of freakin' time of running through a property that just isn't going to work so I can go on to the next one that will.

Posted: 03/29/2008 at 02:23PM

I don't know why but I find it amusing that everyone on this board seems to be quite emphatic about their position on the 50% rule. I can not say one way or the other as I have no rental properties... *yet* but I can see that if it does hold true generally it could be a great time saving analysis formula...

Either way its good to see everyone's prospective on the subject!!